Prepayment Penalties: Efficiency and Predation

41 Pages Posted: 10 Oct 2011 Last revised: 8 Mar 2012

Morgan J. Rose

University of Maryland, Baltimore County; Office of the Comptroller of the Currency

Date Written: March 7, 2011

Abstract

This paper presents evidence that reductions in mortgage interest rates associated with prepayment penalties are greater for riskier borrowers, as measured by mortgage type, credit scores, and local incomes and education levels. This is consistent with an efficiency view arguing that, by reducing the reclassification risk faced by lenders, prepayment penalties can be welfare-improving. Additional findings indicate that prepayment penalties are also used as a predatory lending tool, but the efficiency view dominates the predatory view in most circumstances. State anti-predatory lending laws restricting the duration and amount of prepayment penalties appear to curb the predatory use of prepayment penalties.

Keywords: prepayment penalties, predatory lending, financial regulation, mortgage crisis, reclassification risk

JEL Classification: G21, G28, G01, D18, L85

Suggested Citation

Rose, Morgan J., Prepayment Penalties: Efficiency and Predation (March 7, 2011). Available at SSRN: https://ssrn.com/abstract=1941750 or http://dx.doi.org/10.2139/ssrn.1941750

Morgan J. Rose (Contact Author)

University of Maryland, Baltimore County ( email )

1000 Hilltop Circle
Baltimore, MD 21250
United States
410-455-8485 (Phone)

Office of the Comptroller of the Currency

400 7th Street SW
Washington, DC 20219
United States

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